Borrowers are often provided with various types of loans such as retail loans, cash loans, payroll loans, business loans, etc. In general, all loans are classified as secured and unsecured. Here’s what you need to know about the difference between these loans and what you should choose.
What is a secured loan?
As the name suggests, a secured loan is backed by something that can replace payment in the event of a default by the borrower. This substitute is called bail. The collateral can be your house, car, or other things that are valuable to you, the amount of which can cover the loan that you borrowed. Banks usually ask for collateral when the loan is too large. Since the default of borrowers is inevitable, banks use collateral to cover the loan amount.
For example, if a house is used as collateral and the borrower is unable to repay the loan, the bank has the right to seize the property and sell it. Upon initiation of foreclosure, the borrower must relinquish ownership of the property.
Pros of a secured loan
- Guaranteed approval of the loan application
The first benefit of applying for a secured loan is guaranteed approval. Who doesn’t need a fast approval loan application? Banks and other lending institutions usually approve borrowers if they can provide collateral corresponding to the amount of the loan requested. If you own a property like a house or a car and need cash right away, you can easily get what you need by mortgaging your property. If you intend to repay the loan on a regular basis, you do not need to worry about your collateral being foreclosed. So do not forget to periodically repay loans on time.
- No need for a surety
Since the collateral serves as your backup, in most cases you do not need to introduce a guarantor or co-borrower. Banks and lending institutions will accept collateral as the only backup if it meets their criteria.
- You will be asked to repay the loan in full
Finally, with a secured loan, you will be asked to repay the loan in full. Your property is mortgaged and there is a risk that the lender will foreclose it if you do not pay. That’s enough for you to pay on time if you don’t want your asset to go to waste.
Cons of a secured loan
- You must give up your property in the event of a default
While a secured loan offers certain benefits, it also carries risks. The first risk you should take is the thought that you might have to give up your property in case you can no longer pay the loan. It is for this reason that loans are collateralized. If the borrower can no longer pay, lenders will use the collateral to pay the loan. This is a big risk for borrowers.
- The fair value of your collateral must be greater than your loan amount.
Another disadvantage is that your collateral must meet the standards set by banks and lending institutions. The fair value of your collateral is important in this type of loan.
In most cases, lenders determine fair value based on market prices. They conduct the assessment as part of the process. If your property does not meet the criteria or standards, you may need to provide another property as collateral. Otherwise, your application will be rejected.
- If you do not have a property to mortgage, your loan application will be rejected.
If you do not own real estate that could be used as collateral when applying for a secured loan, this loan is not right for you.
What is an unsecured loan?
An unsecured loan is a type of loan that does not require collateral. As the name suggests, it is “unsecured,” which means that the bank or lender has no property to foreclose if the borrower defaults. Unsecured loans are useful for people who do not own real estate or do not want to pledge their assets. It is also a good option for those who need immediate money.
Advantages of unsecured loans
- No need to leverage your assets
The first reason unsecured loans are a good alternative to borrowers is that no assets are needed to obtain a loan. This means that regardless of whether you own a home or not, you can apply for a loan if you qualify and have all the required paperwork.
- A high credit rating and a good credit history are often sufficient
Unsecured loans are also beneficial to those who have high credit ratings and good credit histories. Most often, a credit rating is sufficient to qualify you for unsecured loans. For example, if you are applying for a cash loan, you do not need to provide a lot of paperwork if you have a high credit rating. Getting approval is easy if you have good records.
- Easy application process
Since unsecured loans do not need collateral, you do not need to go through the appraisal process and wait for the lender to determine the fair value of your property. For borrowers, this means an easier application process. You just need to submit documents and wait for approval.
- Instant cash for qualified borrowers
Unsecured loans are also suitable for those who urgently need cash. You no longer need to look for collateral if you are qualified. Prepare the paperwork, show your credit ratings to a potential lender, and get your loan approved quickly. For those looking for short term loans, unsecured loans are ideal.
Cons of unsecured loans
- High interest rates
Because the loan is unsecured, banks and lending institutions impose high fees and fines for those who violate the terms and conditions. Although you can get the loan straight away, you will have to pay high interest later. Some borrowers may put up with this disadvantage, but it is expensive.
- Bad credit history if you default
If you fail to pay on time or by default, the lender will have to report it, which means that this can affect your credit history. In addition, bad credit will affect your future loan applications. So, if you want to avoid this, you should plan your payment in a timely and intelligent manner.
- Strict credit requirements
Finally, banks and other lenders are strict when it comes to applying. If you do not meet one or two of the requirements, your application will be rejected immediately. This is why it is important to submit complete documents on time. Although the bank will keep track of the details required for the incomplete document submitted, it may queue your application for consideration at a later stage.
How to choose between unsecured and secured loans?
The answer depends on what you are looking for and the purpose of the money you want to borrow.
For borrowers with a large loan amount
Secured loans are best suited for long-term borrowers and those who need a large amount of cash. If you are borrowing to pay for your kids’ schooling, renovating your home, buying other property, or other expensive items, then secured loans are fine. This type of loan has a low interest rate. Even if your payment plan takes a year or more, you won’t be paying high interest.
For borrowers who will use the money for monthly expenses, medical bills, or other short-term expenses, unsecured loans are better suited. However, remember that you have to pay high interest rates. This is the risk that you should take when borrowing unsecured loans. If you do not have real estate to mortgage as well, unsecured loans will be your only choice.
The type of loan you can get will depend on many factors. You also need to consider the requirements. If you think you are not eligible for secured loans, try applying for unsecured loans. If you are in urgent need of cash and want guaranteed approval, then secured loans may be your best bet.